China to lead slowdown across whole of Asia, while the country's shadow
banking system poses a threat to financial stability

China's cooling economy and the looming taper of cheap money in America will drag down growth in East Asia, the World Bank said on Monday, as it slashed growth forecasts across the region.

The world's second largest economy is now expected to expand by 7.5pc this year, down from a previous forecast of 8.3pc in April.

While recent manufacturing data suggested growth was picking up in China, the World Bank added that a "greater than expected slowdown of investment could have an adverse effect on the region, especially on suppliers of capital goods and industrial raw materials."

China's president Xi Jinping said on Monday that he expected a "long and tortuous process" of world economic recovery, while an economic growth rate of about 7pc was "within a reasonable and expected range".

The World Bank also joined the chorus of warnings about China's shadow banking system, which it said posed risks to financial stability.

"The rapid expansion of shadow banking poses serious challenges, since shadow banking is closely linked to the banking system, is less regulated, and operates with implicit guarantees from banks and local governments," the World Bank said in its semi-annual report on the region.

It called on policymakers to rein in the rapid credit growth in the economy and tighten financial supervision in order to contain potential problems.

The International Monetary Fund and rating agency Fitch have issued similar warnings about China's shadow banking system, which has fuelled the explosive credit growth that has helped to drive its economic rebound, but also raised doubts over the ability of borrowers to repay loans.

Although the size of China's shadow banking system is unknown, JP Morgan has estimated it could be as much as 69pc of gross domestic product, or $5.9 trillion.

The World Bank also lowered its growth forecasts for East Asia, which currently contributes 40pc of the world's GDP growth. It now predicts the region will grow by an average of 6pc this year, down from a previous prediction of 6.5pc.

It said lower commodity prices and weaker-than-expected export growth had slowed growth in countries including Indonesia, Malaysia and Thailand.

The downgrades hit Asian shares on Monday. The Nikkei 225 index in Japan closed down 1.2pc at 13,853.32, while Hong Kong's Hang Seng index fell 0.7pc to 22,973.75. Markets were also hit by fears of a US default, after politicians failed to reach a deal to raise the country's debt ceiling over the weekend.

Although the World Bank said worries that the US will pull back its latest quantitative easing programme was a cause for concern, Bert Hofman, the World Bank's East Asia and Pacific chief economist, said Asia's developing economies may get a boost now that growth is finally picking up in the US, Europe and Japan - traditionally their biggest export biggest markets.

"We are seeing a slowdown in domestic demand, which is a headwind, but at the same time Asia is seeing a tailwind from the revival of the rest of the global economy," said Mr Hofman.

The World Bank added that tapering in the US could in part be offset by the huge monetary stimulus in Japan, which will see a doubling of the money supply by the end of 2014.

Hints that the Fed might start to scale back its $85bn (£53bn)-a-month bond buying programme in September rocked developing countries' financial markets and weakened their currencies over the summer as foreign investors started pulling funds out on the expectation of higher returns back home.